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DIGITAL ASSETS AND THE BVI
DIGITAL ASSETS AS FINANCIAL ASSETS
Global regulatory frameworks in financial services have developed to manage the issuing, trading, transferring, and holding of currencies, securities, and financial contracts in the form of options, forwards, and swaps. Securities and financial contracts are often referred to collectively as “financial assets”, that is, some form of tradeable financing instrument. In the world of traditional financial assets, the question whether the business at hand was regulated as a fund, a broker, a bank, or a payment services provider could have been occasionally vexing. Lately, with the rise of FinTech, decentralised finance, and cryptographic assets, the challenge has increased significantly.
With hindsight, determining the perimeter of traditional financial services regulation can be said to have been relatively straightforward. Not so in the crypto world, which has raised a wide range of complex questions. Is a decentralised network of “nodes” some form of undertaking? Is a “smart contract” deployed on that decentralised network a financial asset? Should the ability of a person to acquire a token (that undeniably has monetary value, but exists only as a script logged on decentralised block chained network that is not controlled by a single operator) be equated to the offering of a financial asset to that person? Around the world, legislators and regulators have been grappling with these questions. The most far-reaching attempt
to date appears to be the European Commission’s proposal for a Regulation “on Markets in Crypto-assets”, a proposal that seeks to address a variety of applications ranging from simple coins and stable coins, to tokens that reference real world assets. Despite efforts such as this from the EC, significant challenges remain for individual financial centres to manage when it comes to regulating digital assets.
VIRTUAL ASSET SERVICE PROVIDERS LAWS
Digital assets raise significant challenges in an anti-money laundering context. The Financial Action Task Force (FATF), with support from the G20, issued standards in June 2019 aimed at the prevention of the misuse of virtual assets for money laundering and terrorist financing purposes. In FATF’s context, the term ‘virtual asset’ refers to “any digital representation of value that can be digitally traded, transferred or used for payment. It does not include the digital representation of fiat (government-issued) currencies”. In response, jurisdictions around the world have implemented the FATF recommendation by way of legislation commonly referred to as Virtual Asset Service Providers (VASP) Laws.
The key question under the VASP laws is whether the entity that handles virtual assets in some form is providing a “virtual asset service” within the meaning of the applicable VASP law. If it is, the provider will need to be registered or licensed with the relevant national competent authority. A “virtual asset service” is typically defined in line with the FATF recommendation as the issuance of virtual assets, the business of fiat-to-crypto or crypto-to-crypto exchange services, crypto custody and administration services, and or services such as asset management or brokerage services that concern virtual assets. To date, the British Virgin Islands has not implemented a VASP law, but it is expected that the FATF’s recommendations will be implemented in the BVI fairly soon.
DIGITAL ASSETS AND THE BVI’S TRADITIONAL FINANCIAL SERVICES FRAMEWORK
Anyone conducting business that involves digital assets in or from the BVI may need to consider, separately from any implementation of a VASP law, whether a licence or approval is required under existing primary financial services legislation. Firstly, The Securities and Investment Business Act, 2010 (“SIBA”), which regulates investment business, that is, broker-dealers, investment management and advice, custody and administration, and the operation of an exchange. SIBA provides that, subject to certain exclusions, no person shall carry on, or hold out as carrying on, investment business of any kind in or from within the British Virgin Islands without the requisite licence.
Secondly, The Financing and Money Services Act, 2009 (“FMSA”), which regulates financing and money services business. The FMSA provides that a person shall not carry on, or hold out as carrying on, financing or money services business unless the person is a BVI business company or foreign company and is licensed under the FMSA.
Digital assets do not neatly fit into traditional regulatory definitions of financial assets and this is not different under SIBA and the FMSA. To aid interpretation, the Financial Services Commission (“FSC”), the BVI’s principal financial services regulator, published “Guidance on Regulation of Virtual Assets in the Virgin Islands (BVI)” in July 2020. In relation to SIBA, the FSC’s guidance clarifies that if a digital asset can be equated to a traditional financial asset, depending on whether the activity involved is an investment activity, that this person may need to be licensed. Simple coins would not normally be equated to traditional financial assets under SIBA, but stable coins may, for instance.
Based on the FSC’s guidance, it is also clear that digital asset (price index) futures or other (listed) derivatives, if made on a centralised exchange that matches users, could qualify as traditional financial assets under SIBA. The position in relation to transactions effected via a properly decentralised automated market maker, where the “chain” and not another person is the counterparty, remains to be determined.
The position in relation to the FMSA is more straightforward. The FSC’s guidance states that the FMSA does not apply to transfers and exchanges of digital assets. In other words, to constitute money services business within the meaning of the FMSA, that business would need to concern fiat money. Notwithstanding, the FSC also notes in its guidance that “considering the impending launch of the Regulatory Sandbox, the views and guidance of the FSC should first be secured before proceeding with the activity in or from within the Territory”.
THE REGULATORY SANDBOX
The need to better regulate digital assets has led to the FSC launching a special regulatory approval category known as the “Regulatory Sandbox”. The Regulatory Sandbox, which came into force on 31 August 2020, is designed to offer providers of innovative tech-oriented financial services business models, whether the business is in scope of the existing financial services legislation or not, an option to test that model with the FSC’s stamp of approval.
There are five testing categories: FinTech Credit Services, Payments, Investment Management, Securities, and Insure Tech. Applications are open to BVI companies and limited partnerships, foreign companies, BVI licensees, and any other person that the Commission may decide to approve to participate in a Regulatory Sandbox. In each case, the essential criteria is that the applicant is proposing to engage or is engaged in “innovative FinTech”.
The FSC has indicated that in assessing and approving an application for a Regulatory Sandbox, its focus will be on the management of the risks associated with the proposed FinTech business model. Accordingly, the Regulatory Sandbox is not intended as an open-ended “incubator” Sandbox but as a testing ground for reasonably well-defined (start-up) business models that will be resourced properly.
Once accepted to the Regulatory Sandbox, the participant is exempted from the provisions of financial services legislation that might otherwise apply (with the exception of the rules and regulations relating to the combatting of money-laundering and terrorist financing). In this manner, participating in the Regulatory
Sandbox brings certainty to those businesses that are currently out of scope of the financial services legislation but might be brought in scope, e.g. if the views on what type of crypto assets constitute “investments” or not, or if crypto coins are equated to fiat money for purposes of the financial services legalisation.
DIGITAL ASSETS AND BVI INVESTMENT FUNDS
The Securities and Investment Business Act also regulates the business of open-ended and closed-ended investment funds. FSC approval is required for doing business in the BVI as an openended mutual fund or closed ended private investment fund.
In all cases, the key determinant is whether the vehicle “collects and pools investor funds for the purpose of collective investment”. Accordingly, the SIBA perimeter for funds is asset class agnostic. Whether or not a vehicle requires recognition or approval as a fund will not depend on the character of the property acquired for purposes of collective investments, and therefore does not necessarily exclude funds that invest in digital assets. Indeed, funds that invest in digital assets have been a staple of the BVI fund world since the crypto sector first took off.
The BVI’s fund recognition and approval regime features a number of flexible categories. In the open-ended space, the incubator fund is designed to launch new investment strategies. It offers a twoyear licence (with an extension option of up to 12 months) which permits the establishment of a track record. The approved fund permits a private offering to a small group of investors, limited to 50 investors at any one time or be marketed on a private basis only. That means a private fund may be a pragmatic solution for a closed circle crypto sector offering. The professional fund permits offerings to ‘professional investors’ only, with a minimum initial investment not less than US$100,000.
A BRIGHT FUTURE
The global cryptocurrency market – just one part of digital assets –is forecast to rise from US$750 million in 2019 to US$1.75 billion by 2027. Through its existing well-established regulatory and legislative framework, combined with innovative new concepts such as the Regulatory Sandbox, the BVI is uniquely well-placed to serve this growing market and act as home to the digital asset funds of the future.
